Medical Device Link.

Originally Published IVD Technology January/February 2004

DIAGNOSTIC OUTSOURCING

Outsourcing portions of an IVD company's workload may confer an advantage in terms of both R&D and production efficiency.

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As the technology available for IVD systems becomes increasingly sophisticated, IVD manufacturers may need to invest much of their resources in research and development (R&D) in order to deliver increasingly sophisticated tests to market. When, simultaneously, these manufacturers have to meet their customers' demand for their established products, outsourcing portions of their manufacturing processes may be a viable way to make the most efficient use of the company's resources. In addition to balancing production and R&D needs, outsourcing may offer an IVD company the opportunity to broaden its product portfolio by providing the access to skill sets and core competencies outside the areas in which its in-house team specializes.

IVD Technology recently convened a roundtable of IVD industry executives representing companies of differing size, scope, and business focus to discuss the value of outsourcing for IVD manufacturers, and the best way to manage a relationship with an outsourcing partner. The roundtable participants are introduced in a sidebar.

IVD Technology: How does an IVD company decide that a particular project will require the outsourcing of certain manufacturing operations to other companies?

Brian Richards: Generally, it is an economic exercise, and companies usually base these decisions on the capital requirements of a particular project. If somebody outside the company can provide a service more cost-effectively, then we may decide to outsource the work.

Michael Whelan: Our company outsources only a few portions of its manufacturing processes. We use outsourcing more for R&D. The decision to outsource has been based on the need for a particular skill set that we will use to complement our current in-house R&D process.

Gurney Lashley: Our company approaches manufacturing from a project management standpoint. We will outsource work if R&D is pursuing a technology in which it does not have a core competency, or if we need additional equipment or capacity to meet a production need. In those cases, we will outsource until we have sufficient volume or a sufficient market demand to purchase equipment internally.

If our company has the capability to perform the necessary tasks in-house, then we will probably do the job ourselves. If we do not have the capability, then we will determine whether we want to develop that capability or we want to outsource. Generally, we will outsource, at least at the beginning of the project, if we do not have the necessary manufacturing capabilities.

IVDT: If your company could not find a vendor that could provide a service more cost-effectively, would your company be more inclined to do it in-house?

Richards: If a capable and cost-effective vendor cannot be identified, the company's options are limited. In that case, the company would do it in-house or not at all. But for jobs that are of low technical complexity, typically companies are looking for vendors that have already invested in the necessary capital equipment to do the process, and they are trying to amortize their costs over larger volumes. If, by using their services, you can get those components produced for less money than it would cost in-house, then outsourcing is certainly an option to entertain.

Whelan: I would second that. There are instances where a simple technology, like a plastic molded part or a replacement consumer part, can be produced by other companies at a lower cost. Historically, we have produced these parts in-house.

Deciding to Collaborate

IVDT: What specific tasks do you outsource?

Whelan: We outsource a variety of tasks. We outsource a high volume of low-technology plastic molded components. We also outsource reagents and other consumables--some shipped in bulk and then packaged by us into individual containers, some shipped to us in finished format. In some cases, we have complete instrument systems shipped to us with our name on them. We also work with vendors that make key components of a reagent design that we then incorporate into the development of reagent systems.

Lashley: Our company also puts its name on some instrumentation systems produced by an OEM manufacturer. We will also outsource low-volume reagents that we are not equipped to handle early on, before bringing them in-house. Generally, these reagents are outsourced at the beginning of a project when we conduct the preclinical studies. Then, once we have determined that the project is something that we will pursue as a product, we will bring the reagents in. On an ongoing basis though, we really do not purchase reagents from outside vendors.

Richards: We, too, outsource low-tech plastic parts in fairly high volumes, and we have on occasion changed vendors based on quality concerns and considerations. We outsource instrument systems on an OEM basis as well. And I think my earlier comment about the supplier being virtual is a key point because, by virtue of the labeling, we are the recognized manufacturer.

IVDT: At what point during a product development cycle should an IVD manufacturer get an outsourcing company involved?

Richards: From the IVD company's perspective, we want to do it as soon as we can. From the supplier's perspective, however, they will need as much information as they can get in order to provide an accurate quote. In the case of providing an instrument system, they will need enabling documentation in order to do a fixed-price quote. The necessary documentation will not be available early on in a project. It is important to recognize that the vendor's quote will only be as good as the information that you can give it.

Lashley: If we are working on an instrumentation system, the more complex it is, the earlier we will get the outsourcing vendor involved, because there are issues that they may have to address with their own capabilities. For simpler jobs, we will work the design out first and then give the vendors drawings from which they can develop a mold.

Whelan: Depending on a product's complexity, a partner may be brought in during the planning stage to incorporate its expertise into the creation of the product specifications.

IVDT: What do you hope to accomplish by outsourcing manufacturing operations?

Lashley: If we can find a vendor that will produce reagents faster than we can on some small-volume items, then we will save some time by outsourcing to them. We will also use outsourcing to expand our capabilities, and you could consider that a cost savings. For instance, we do not, at least at this point in time, want to be an instrument manufacturer. So, we will expand our capabilities by going to another company and outsourcing the instrumentation portion of a product.

Richards: By outsourcing things that would otherwise consume resources, companies can gain additional time to work on multiple parts of a project simultaneously.

Whelan: Outsourcing can satisfy a time-to-market issue, and allow for the development of other projects in parallel in order to bring a greater variety of product offerings to the customer.

Establishing a Partnership

IVDT: What do you look for in an outsourcing company?

Whelan: We have a fairly aggressive R&D program. Our company considers time to market very important. As a result, we look for companies that have expertise in areas like cytokines, or that have a biological focus. Many such companies are well-known entities that have a good reputation for producing components, so we do outsource to them. We have a contract development program, but we use it primarily to provide key components. Scale-up and kitting is done in-house.

Richards: To follow up on that comment: in general, these decisions are made on a case-by-case basis. Manufacturing companies seek to leverage their core competencies with those of other companies to end up with a quality product delivered on schedule and within budget.

IVDT: Once you have identified aspects of a project that will be outsourced, do potential outsourcing companies use a competitive bidding process to present themselves as candidates?

Whelan: If the production of a low-tech item is being outsourced, then it is in our interest to go through a bidding process that would be handled by the supply chain organization. If we are outsourcing the production of a high-tech item, then the selection of a vendor is based on technical capability and business relationship.

Lashley: I agree. For instance, when dealing with instrument manufacturers, we will approach manufacturers with which we have a prior relationship, manufacturers we know will have the capabilities that we are looking for. If we come out with a new instrument and do not believe our existing vendors have the necessary capabilities, then we find other vendors that have those capabilities. Once we have narrowed the field down to the capable vendors, then we will have a competitive bidding situation between a limited number of vendors.

Richards: We outsource instrument manufacturing as well. In a regulated environment, the outsourcing company is virtual, from the perspective of the end-user. By virtue of the fact that our company's name is on the label, we are the sole manufacturer. So, we have to be confident in the capabilities of the supplier. In that case, the process of selecting a vendor goes beyond purely economic considerations.

IVDT: So, it seems that there is a due diligence process involved in selecting a vendor. Please describe the steps that go into that process.

Lashley: First, we check the company's financials to make sure that it is not going to go out of business any time soon. We check references supplied by the company, and we assess the company's capabilities from an engineering standpoint. In addition, we visit their plants to ensure they have sufficient manufacturing capabilities, and we meet with their top-level management team to gain confidence that they can do what they say they can, and to make sure that we have a good rapport with them. We also check their quality systems to make sure that they have met the quality system regulations, and that they can deliver the detailed paperwork, design criteria, etc., that we will need to produce a regulated piece of equipment.

IVDT: Are you more inclined to work with companies with which you have had long-standing relationships, or are you open to working with companies that you have never worked with before?

Richards: I think most IVD companies want to leverage off of the good relationships that have been established, but they also should put some checks and balances in place. So it does not hurt if companies take the opportunity to check up on their suppliers. If a company can check on pricing, for example, it keeps suppliers on their toes, especially when there are provisions in the contracts for price adjustments.

Whelan: The easy part, in some respects, is the selection of a partner. The ongoing management of that partnership requires more finesse. It is a combination of program management and supply chain organization. Companies need to have an infrastructure in place to aggressively execute ongoing management of the agreement.

Lashley: I believe that it is probably easier for a vendor to disqualify itself after working on a project than it is to ensure that they are included in the next project. That notion puts a lot of pressure on both companies to ensure that things run smoothly. When we find a vendor that has been reliable and delivers a quality product per the schedule, then we like to continue working with them, but not to the exclusion of other companies. Certainly if the pricing gets out of line, we will move on.

Managing the Relationship

IVDT: How do you oversee and monitor the progress of the vendors that work on jobs for you, to make sure that they stick to the schedules that have been established?

Lashley: Both our project managers and the members of our project's core team visit the vendors. Periodically, we will have review meetings at both the supplier's site and at our site. We lay out fairly detailed schedules early in the process, and we have the vendors buy into those schedules. We maintain continuous communication with the vendor. Our meetings with the vendor will take place on a weekly basis, or on a monthly basis, depending upon the stage of the project.

Whelan: If an IVD company has laid a sound foundation in the beginning with the partnership agreement, then it should have no problem establishing various milestones and goals to meet along the way. I would concur that managing a relationship with a vendor does require weekly communications, most definitely monthly communications, and often physical visits to the partner's sites.

Richards: We use a project management form of design control as well. For critical components, we have a monthly meeting with the supplier where we forecast our requirements. Companies should be careful to provide themselves with the flexibility they need as a consumer when they set up these supply contracts. Suppliers will request some definite forecasts so they can schedule their resources, but an IVD company will not want to preclude any kind of flexibility. That is a difficult thing to manage in the relationship, but it is possible through good communication.

IVDT: What are the primary challenges in working with companies that you outsource to?

Whelan: Usually a company outsources work because there is an independent value associated with that outsource, be it technical aptitude or the ability to do a job more quickly. Integrating an independent company into your business is, in itself, a challenge. To meet that challenge, we have initiated a position we call "relationship manager."

The objective of that position varies depending on the complexity of the business arrangement, so some suppliers need that extra support and some do not. If the supplier is involved in a complex product, and depending on where they are located, the relationship manager can be a very important part of the process that allows us to maintain independence, yet avoid surprises.

Lashley: Maintaining a good relationship can be difficult when your company has tight schedules, is being pushed by marketing to get a project out, and is in turn pushing the vendor to get a project out. Communication becomes extremely important. It is very important in the beginning to create a well-thought- out agreement regarding how you are going to handle forecasting of the part or the equipment, how you are going to react to changes, who the major contacts are, and how the information will flow. Companies will want to avoid placing the vendor in contact with a large number of people within its own organization, and vice versa, because companies will want to make sure that consistent messages are being sent and received.

IVDT: In a worst-case scenario where things go completely wrong on the outsourcing company's part for whatever reason, what can be done?

Richards: Hopefully, the IVD company has done its homework and does not end up in that situation. However, the volumes required by some projects dictate that a company may not be able to rely on one supplier and may have to qualify two or three suppliers. If one was to fall short, then there would be an inherent contingency. Another way to prevent a shortage is to build up an inventory of the material in-house, so that if something does go wrong with the suppliers, the company has a bit of a buffer. Obviously, there is a cost to that because it involves tying up working capital.

Lashley: Again, I think the initial agreement is extremely important. If a company is developing an instrument, it will want to make sure that it has access to all the intellectual property and the drawings that have been developed. Companies should set milestones that the vendor must meet. If the vendor is incapable of meeting them, then the company should not lose all the work that has been put into that project. The company should be able to pull the drawings and any materials that were purchased and move them to another supplier.

Whelan: If a low-technology, high-volume component like a plastic part is being outsourced, then usually the supply-chain people will write clauses into the contract to cover these issues, and it does not always mean that the supplier's mistake is its cost. In the interest of a good relationship, there may end up being some sharing of the cost in order to arrive at a solution. For a critical component, the supply chain will usually have a primary or secondary supplier.

In the case of a high-technology, low-volume component, then the companies are dependent on the original partnership agreement. If there is a problem, the companies may have to share in the cost of fixing it, which may mean that the manufacturing process will have to be changed so the cost rises by 10%. The companies might agree to do this because it supports the partnership.

Effect on Business

IVDT: Over the years, has outsourcing offered significant cost savings, time savings, and efficiency to your companies' operations?

Richards: Absolutely, because we are outsourcing things that for a variety of strategic business reasons we do not currently manufacture. So if we had not been able to find a solution through outsourcing, we would not be where we are today.

Lashley: I agree with that 100%. There are items that we outsource that we do not have the capability to do in-house, nor do we want to develop that capability. Generally, we outsource highly specialized components that require highly specialized skills to manufacture. Other than plastic components, we do not outsource many low-tech items, except on an interim basis.

Whelan: I would agree with all of that. We do not necessarily look to save money by outsourcing, we look to augment our various resources with the partnership of an external source. We have not done an assessment to determine whether we save money. However, we have probably made more money by having that extra capability.

IVDT: Is outsourcing something that bigger companies or smaller companies would be more inclined to do?

Whelan: There is no simple answer to that question. As a larger company, we handle most jobs ourselves. Historically, we forge, bend metal, machine, drill, assemble, etc. But there are instances where, as the business gets more complex, we may not have enough time or the right skill sets to produce low-cost component instrumentation, as opposed to more-complex high-cost components.

Richards: As a small diagnostics company, we were forced to look for outsourcing opportunities so that we could develop our initial products and our new diagnostic platform. As a result, we developed good relationships with outsourcing companies that we have carried forward.

Lashley: I have worked for some fairly large diagnostics companies, a small one, and now for what I consider a medium-sized company. I tend to find that the smaller the company, the more receptive it is to outsourcing, simply because, as Brian said, it generally will not have the capital to invest in different types of equipment, etc. They may be--and start-up companies will be--unsure of whether their products will be successful. As a company becomes larger, has more products on the market, gains more confidence, and has more capital at its disposal, it will tend to bring more jobs inside. Then the company can leverage its own equipment for new products, and it will have a little more flexibility than when it was a smaller company.

IVDT: Do you believe IVD manufacturers will be inclined to outsource more or less of their operations in the future?

Richards: As a company's landscape changes, the amount of work that it outsources changes. As our company grows and the demand for our products increases, we will see some economy of scale and we will make the capital investment in equipment to bring some more of these activities in-house because it will be more beneficial for us.

Lashley: Companies will try to bring more things in-house as a product goes into a more mature life cycle. However, I believe that with continued product innovation and new development, there will always be a good market for outsourcing, especially early in the development cycle of a product. At least that has been our approach.

The need for a continued reliance on outsourcing depends on a company's core competency. The company will want to maintain its core competency and not outsource that type of service. Companies will probably want to continue to outsource jobs for which they do not want to develop a core competency, such as plastic molding. They may decide to bring plastic molding in-house if they have reached critical mass. It is hard to envision getting to that point because so many plastic molders do a very good job, and developing that competency would be quite expensive.

Whelan: Sometimes when our company is contracting in the development phase, we will make a commitment to remain with that partnership into the foreseeable future, in increments of 10 years or more. So while the amount of dollars invested in outsourcing may grow, the number of partners may not grow exponentially.

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